Securities and Exchange Commission v. One or More Unknown Traders in the Common Stock of Certain Issuers

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
SECURITIES AND EXCHANGE :
COMMISSION, :
:
Plaintiff, : Civil Action No.: 07-0431 (RMU)
:
v. : Re Document Nos.: 39, 40
:
ONE OR MORE UNKNOWN TRADERS :
IN THE COMMON STOCK OF :
CERTAIN ISSUERS et al., :
:
Defendants. :
MEMORANDUM OPINION
GRANTING THE PLAINTIFF’S MOTION FOR DEFAULT JUDGMENT
AND FOR A PERMANENT INJUNCTION
I. INTRODUCTION
This matter comes before the court on the plaintiff’s motion for default judgment
pursuant to Federal Rule of Civil Procedure 55(b)(2). The plaintiff, the Securities and Exchange
Commission (“SEC”), brings this action against four individuals who engaged in a “pump-and-
dump” market manipulation scheme in violation of the Securities Act of 1933 (“Securities Act”),
15 U.S.C. § 77q(a), the Securities and Exchange Act of 1933 (“Exchange Act”), 15 U.S.C. §
78j(b), and 17 C.F.R. § 240.10b5 (“Rule 10b-5”). The plaintiff served the defendants with a
copy of the complaint on March 27, 2007, and to date the defendants have not responded to the
complaint. Accordingly, the court grants the plaintiff’s motion for a default judgment and
permanent injunction.
II. FACTUAL & PROCEDURAL BACKGROUND
The plaintiff commenced this action on March 6, 2007, alleging that between December
21, 2005, and December 4, 2006, the defendants, using a number of sub-accounts held at
Pinnacle Capital Markets LLC (“Pinnacle”) and titled in the name of relief defendant JSC Parex
Bank (“Parex”), traded in the securities of issuers whose share prices were being manipulated
through online intrusions and engaged in unauthorized trading in the online brokerage accounts
of unsuspecting customers at U.S. broker-dealers. See generally Compl. On March 6, 2007, the
court granted the plaintiff’s motion to serve the defendants through Pinnacle and Parex. See
Order (Mar. 6, 2007). In compliance with the court’s order, the plaintiff served Parex with
copies of the summons and complaint by sending copies of those documents via e-mail and
Federal Express to Pinnacle’s president, Michael A. Paciorek. Decl. of Att’y Kenneth J. Guido
(“Guido Decl.”) ¶ 6. On March 7, 2007, Paciorek forwarded the summons and complaint to
Parex by electronic mail and Federal Express with instructions to serve the documents upon the
defendants. Id. ¶ 7. Parex identified the defendants as Anna Gorelova, Oleg Kopylov, Sergey
Kovalev and Dmitriy Philin and certified that on March 21, 2007, it served them with the
summons and complaint. Id. ¶ 8; see also id., Ex. D.
On March 23, 2007, the court issued an order granting the plaintiff’s unopposed motion
for a preliminary injunction prohibiting the defendants from committing further violations of the
Securities Act and the Exchange Act, freezing the defendants assets, providing for expedited
discovery, preventing the destruction of evidence and ordering the defendants to provide an
accounting for the transactions described in the complaint. See generally Order (Mar. 23, 2007).
The court also concluded that it had subject matter jurisdiction over this action, personal
jurisdiction over the defendants and that the defendants have been served with process. Id. at 2-
3.
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Because the defendants failed to appear, plead or otherwise defend themselves in this
action, the Clerk of the Court entered default against those defendants on August 4, 2008.
Clerk’s Entry of Default (Aug. 4, 2008). The plaintiff filed this motion for a default judgment
and permanent injunction on October 26, 2009. See generally Pl.’s Mot. Despite being served
with a copy of this motion, the defendants have failed to respond.
III. ANALYSIS
A. Legal Standard for Entry of Default Judgment Under Rule 55(b)(2)
A court has the power to enter default judgment when a defendant fails to defend its case
appropriately or otherwise engages in dilatory tactics. Keegel v. Key W. & Caribbean Trading
Co., 627 F.2d 372, 375 n.5 (D.C. Cir. 1980). Rule 55(a) of the Federal Rules of Civil Procedure
provides for entry of default “[w]hen a party against whom a judgment for affirmative relief is
sought has failed to plead or otherwise defend as provided by these rules.” FED. R. CIV. P. 55(a).
Upon request of the party entitled to default, Rule 55(b)(2) authorizes the court to enter against
the defendant a default judgment for the amount claimed and costs. Id. 55(b)(2).
Because courts strongly favor resolution of disputes on their merits, and because “it
seems inherently unfair” to use the court’s power to enter judgment as a penalty for filing delays,
modern courts do not favor default judgments. Jackson v. Beech, 636 F.2d 831, 835 (D.C. Cir.
1980). Accordingly, default judgment usually is available “only when the adversary process has
been halted because of an essentially unresponsive party . . . [as] the diligent party must be
protected lest he be faced with interminable delay and continued uncertainty as to his rights.” Id.
at 836 (quoting H. F. Livermore Corp. v. Aktiengesellschaft Gebruder Loepfe, 432 F.2d 689, 691
(D.C. Cir. 1970)).
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Default establishes the defaulting party’s liability for the well-pleaded allegations of the
complaint. Adkins v. Teseo, 180 F. Supp. 2d 15, 17 (D.D.C. 2001); Avianca, Inc. v. Corriea,
1992 WL 102999, at *1 (D.D.C. Apr. 13, 1992); see also Brock v. Unique Racquetball & Health
Clubs, Inc., 786 F.2d 61, 65 (2d Cir. 1986) (noting that “default concludes the liability phase of
the trial”). Default does not, however, establish liability for the amount of damage that the
plaintiff claims. Shepherd v. Am. Broad. Cos., Inc., 862 F. Supp. 486, 491 (D.D.C. 1994),
vacated on other grounds, 62 F.3d 1469 (D.C. Cir. 1995). Instead, “unless the amount of
damages is certain, the court is required to make an independent determination of the sum to be
awarded.” Adkins, 180 F. Supp. 2d at 17; see also Credit Lyonnais Secs. (USA), Inc. v.
Alcantara, 183 F.3d 151, 155 (2d Cir. 1999) (stating that the court must conduct an inquiry to
ascertain the amount of damages with reasonable certainty). The court has considerable latitude
in determining the amount of damages. Jones v. Winnepesaukee Realty, 990 F.2d 1, 4 (1st Cir.
1993). To fix the amount, the court may conduct a hearing. FED. R. CIV. P. 55(b)(2). The court
is not required to do so, however, “as long as it ensure[s] that there [is] a basis for the damages
specified in the default judgment.” Transatlantic Marine Claims Agency, Inc. v. Ace Shipping
Corp., Div. of Ace Young Inc., 109 F.3d 105, 111 (2d Cir. 1997).
B. The Court Grants the Plaintiff’s Motion for Entry of Default Judgment
1. The Defendants are Liable to the Plaintiff
The plaintiff asserts that default judgment is appropriate because the defendants have
been unresponsive throughout the adversarial process. Pl.’s Mot. at 6. Because the defendants
failed to plead or otherwise defend themselves in this action, the Clerk of the Court entered
default on August 4, 2008 pursuant to Federal Rule of Civil Procedure 55. See Clerk’s Entry of
Default (Aug. 4, 2008). Since that time, the defendants have not responded to either the initial
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complaint or this motion, despite being served with copies of both. See Guido Decl., Ex. C.
Given the defendants’ failure to respond, the entry of default judgment is appropriate. See, e.g.,
H.F. Livermore Corp., 432 F.2d at 691 (holding that default judgment is appropriate when “the
adversary process has been halted because of an essentially unresponsive party”).
The defendants’ default constitutes an admission of liability for the well-pleaded
allegations in the complaint. Int’l Painters & Allied Trades Indus. Pension Fund v. R.W. Amrine
Drywall Co., 239 F. Supp. 2d 26, 30 (D.D.C. 2002); see also Black v. Lane, 22 F.3d 1395, 1399
(7th Cir. 1994); Trans World Airlines, Inc. v. Hughes, 449 F.2d 51, 63 (2d Cir. 1971), rev’d on
other grounds, 409 U.S. 363 (1973). The plaintiff alleges that the defendants participated in a
trading scheme that violated § 17(a) of the Securities Act, § 10(b) of the Exchange Act and Rule
10b-5. See generally Compl. Accordingly, the court deems these well-pleaded allegations
admitted, and must now determine the appropriate relief.
2. The Plaintiff Is Entitled to the Relief It Seeks
a. Disgorgement
The plaintiff seeks an order requiring the defendants to disgorge all illegal profits and pay
prejudgment interest to the plaintiff. See generally Compl.; Pl.’s Mot. at 9. A district court has
broad equitable power and discretion to order disgorgement of profits from illegal activities. See
Sec. & Exch. Comm’n v. Bilzerian, 29 F.3d 689, 696 (D.C. Cir. 1994) (holding that disgorgement
is remedial in nature and does not constitute a penalty); Secs. & Exch. Comm’n v. First City Fin.
Corp., 890 F.2d 1215, 1230 (D.C. Cir. 1989) (explaining that “[d]isgorgement is an equitable
remedy designed to deprive a wrongdoer of his unjust enrichment and to deter others from
violating the securities laws”).
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An evidentiary hearing is not necessary when “the amount claimed is a liquidated sum or
one capable of mathematical calculation.” James v. Frame, 6 F.3d 307, 310 (5th Cir. 1993). The
amount of disgorgement “need only be a reasonable approximation of profits causally connected
to the violation.” First City Fin. Corp., 890 F.2d at 1231. If disgorgement calculations cannot
be exact, the risk of uncertainty falls on the wrongdoer, whose illegal conduct created the
uncertainty. Sec. & Exch. Comm’n v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996).
The total ill-gotten profits realized by the defendants as a result of the unlawful scheme
described in the complaint amounts to $784,724.11. Guido Decl. ¶ 16. Specifically, the plaintiff
contends that Gorelova realized $57,278.56, Kovalev realized $368,378.16, Philin realized
$134,917.33 and Kopylov realized $224,150.06 in illegal profits. Id. ¶¶ 92-95. All of the
defendants’ proceeds are allegedly held in an omnibus account titled in the name of Parex and
held at Pinnacle’s clearing firm, Penson Financial Services. Id. ¶ 96. The plaintiff calculated the
defendants’ illegal profits by identifying the specific stocks at issue, tracking the day or days on
which the defendants traded in these stocks and the opening and closing prices of those stocks
during the time it was traded by the defendants between December 2005 and December 2006.
Id. ¶¶ 17-95. The plaintiff then took the number of stock shares at issue accumulated by the
defendants at a given price and subtracted that from the number of stock shares sold by the
defendants at the higher price artificially created by the defendants’ illicit conduct. Id. Because
the plaintiff calculated these figures by tracking the illegal trades made by the defendants
between December 2005 and December 2006, id., the amounts are sufficiently reasonable
estimates of the illicit profits, First City Fin. Corp., 890 F.2d at 1231 (determining that
“disgorgement need only be a reasonable approximation of profits causally connected to the
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violation . . . [and] courts typically require the violator to return all profits made on the illegal
trades”). Accordingly, the court orders each defendant to disgorge the foregoing amounts.
b. Prejudgment Interest
The plaintiff also seeks prejudgment interest on the disgorged profits through the date of
the court’s final judgment and requests that the court calculate the interest using the Internal
Revenue Service (“IRS”) underpayment rate. See generally Compl.; Pl.’s Mot. at 11. Assessing
prejudgment interest on disgorgement enables the SEC to “recover the full amount of the
defendants’ unjust enrichment and to provide the possibility of complete compensation to the
defrauded investors.” Secs. & Exch. Comm’n v. Levine, 517 F. Supp. 2d 121, 141 (D.D.C.
2007). The prejudgment interest can be calculated by using the rate that the IRS employs for tax
underpayment. See 26 U.S.C. § 6621(a)(2); Secs. & Exch. Comm’n v. First Jersey Sec., 101 F.3d
1450, 1476 (2d Cir. 1996) (explaining that “[w]hen the SEC itself orders disgorgement . . . the
interest rate it imposes is generally the IRS underpayment rate”) (internal citations omitted); see
also Endico Potatoes v. CIT Group/Factoring, 67 F.3d 1063, 1071-72 (2d Cir. 1995) (holding
that “[t]he decision whether to grant prejudgment interest and the rate used if such interest is
granted are matters confided to the district court’s broad discretion”) (internal quotations
omitted). Accordingly, in addition to the award of disgorgement, the court orders the defendants
to pay prejudgment interest through the date of the court’s final judgment calculated using the
IRS underpayment rate. 1
c. Civil Penalties
The plaintiff asks the court to impose the maximum third-tier civil penalty for each
defendant. See generally Compl.; Pl.’s Mot. at 12. Section 20(d) of the Securities Act and §
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The IRS underpayment rate is determined on a quarterly basis and is the sum of the federal
interest rate plus three percentage points. 26 U.S.C. § 6621.
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21(d) of the Exchange Act set the standards for the imposition of civil monetary penalties. The
two statutes are identical in establishing three tiers of penalties. See generally 15 U.S.C. §§
77t(d)(2), 78u(d)(3). The purpose of a civil penalty is to punish the individual violator and deter
future violations. Secs. & Exch. Comm’n v. Kenton Capital, Ltd., 69 F. Supp. 2d 1, 17 (D.D.C.
1998). The statute provides that any civil penalty is to be determined by the court “in light of the
facts and circumstances” of the particular case. 15 U.S.C. §§ 77t(d)(2)(A), 78u(d)(3)(B)(i).
Third-tier penalties apply when a defendant’s conduct “involved fraud, deceit, manipulation, or
deliberate or reckless disregard of a regulatory requirement,” and the violation “directly or
indirectly resulted in substantial losses or created a significant risk of substantial losses to other
persons.” Id. §§ 77t(d)(2)(C), 78u(d)(3)(B)(iii). Under the third tier, the court may impose a
penalty not to exceed the greater of $130,000 2 on an individual defendant for each violation or
the gross amount of pecuniary gain to the defendant as a result of the violation. Id.
The defendants, by virtue of their default, have conceded the allegations against them.
See infra Part III.B.1. The plaintiff alleges that the defendants intruded into the accounts of
unsuspecting customers and placed unauthorized trades in their accounts, manipulating the stock
prices of at least fifteen companies and reaping substantial profits. Pl.’s Mot. at 13. Taking
these allegations as true, the fraudulent and manipulative nature of this scheme is sufficient to
satisfy the first criterion for third-tier civil penalties. See Sec. & Exch. Comm’n v. Aimsi Techs.
Inc., 650 F. Supp. 2d 296, 307 (S.D.N.Y. 2009) (imposing third-tier penalties because the
defendants engaged in a scheme to fraudulently inflate the price and trading volume of stock and
sold it at the inflated prices); Sec. & Exch. Comm’n v. CMKM Diamonds, Inc., 635 F. Supp. 2d
1185, 1192 (D. Nev. 2009) (imposing third-tier penalties because the defendants fraudulently
2
The penalties enumerated in the statutes, see 15 U.S.C. §§ 77t(d)(2)(C), 78u(d)(3)(B)(iii) (noting
a $100,000 third-tier penalty), are adjusted periodically for inflation, see 17 C.F.R. § 201.1003(2010).
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traded stock, conducted fraudulent transactions, manipulated stock and deceived the public);
Secs. & Exch. Comm’n v. McCaskey, 2002 WL 850001, at *13 (S.D.N.Y. Mar. 26, 2002)
(imposing third-tier penalties because the defendant manipulated stock to stabilize or artificially
raise its price).
The defendants’ alleged conduct also satisfies the second requirement for the imposition
of third-tier civil penalties because their fraud created substantial losses or a significant risk of
substantial losses to the victims whose accounts the defendants utilized, the broker-dealers who
incurred financial damages in making their customers whole as well as the market participants
who traded the securities that were manipulated by the defendants. See Secs. & Exch. Comm’n v.
World Info. Tech., Inc., 590 F. Supp. 2d 574, 578 (S.D.N.Y. 2008) (holding that the defendant’s
conduct, which induced investors to purchase $440,000 worth of valueless stock and yielded the
defendant $117,500 in ill-gotten profits, created substantial losses or risk of substantial losses to
the investors); Secs. & Exch. Comm’n v. Tanner, 2003 WL 21523978, at *2 (S.D.N.Y. July 3,
2003) (holding that the defendant’s stock manipulation scheme, which yielded him $92,000 in
ill-gotten profits, caused substantial losses or the risk of substantial losses to investors who
purchased the inflated stock); Secs. & Exch. Comm’n v. Bocchino, 2002 WL 31528472, at *4
(S.D.N.Y. Nov. 8, 2002) (determining that the defendant’s scheme to fraudulently inflate stock
values, which yielded him $35,090 in ill-gotten profits and caused $808,875 in losses to
investors sufficiently resulted in substantial losses or the risk of substantial losses to investors).
Accordingly, the court grants the plaintiff’s request to impose the following maximum third-tier
penalties pursuant to section 20(d) of the Securities Act and section 21(d) of the Exchange Act:
(1) as to Kovalev: $368,378.16, representing the amount of his pecuniary gain; (2) as to Philin:
$134,917.33, representing the amount of his pecuniary gain; and (3) as to Kopylov: $224,150.06,
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representing the amount of his pecuniary gain. With respect to Gorelova, the court imposes a
penalty of $130,000, which amount represents the greater of $130,000 or Gorelova’s pecuniary
gain of $57,278.56.
d. The Plaintiff is Entitled to Injunctive Relief
The plaintiff seeks a permanent injunction that
permanently restrains and enjoins the trader defendants, and each of their agents,
servants, employees, attorneys and all persons in active concert or participation
with them who receive actual notice of the injunction by personal service or
otherwise, and each of them, from future violations of Section 17(a) of the
Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5.
Compl., Prayer for Relief ¶ I.
The SEC is entitled to seek a permanent injunction for violations of the Securities Act
and the Exchange Act. 15 U.S.C. §§ 77t(b), 78u(d)(1), 78u(e). The court has discretion to grant
a permanent injunction when “there is a reasonable likelihood of further violation(s) in the
future.” Secs. & Exch. Comm’n v. Savoy Indus., Inc., 587 F.2d 1149, 1168 (D.C. Cir. 1978).
Determining the propensity for future violations requires examining the totality of the
circumstances. First City Fin. Corp., 890 F.2d at 1228. The relevant factors to consider are
“whether a defendant’s violation was isolated or part of a pattern, whether the violation was
flagrant and deliberate or merely technical in nature, and whether the defendant’s business will
present opportunities to violate the law in the future.” Id. The combination of the first two
factors alone is sufficient to justify injunctive relief prohibiting future violations of the securities
laws. See Bilzerian, 29 F.3d at 695 (determining that the defendant’s pattern of flagrant conduct
warranted an injunction); Secs. & Exch. Comm’n v. Blatt, 583 F.2d 1325, 1334-35 (5th Cir.
1978) (determining that the nature and extent of the securities violations warranted an
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injunction); Secs. & Exch. Comm’n v. Mgmt. Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975)
(determining that the serious and intentional nature of defendant’s conduct warranted an
injunction).
In this case, the defendants engaged in illegal securities trading of at least fifteen
companies over the course of approximately one year. Compl. ¶¶ 12-14. Furthermore, the
defendants intruded into the online brokerage accounts of unsuspecting customers at U.S. broker-
dealers, masking their identities through the use of hijacked Internet Protocol addresses. Id. ¶¶
1-2. Given that the defendants’ misconduct was not isolated and that the defendants acted
deliberately in carrying out their unlawful trading scheme, there is a reasonable likelihood of
future violations. Bilzerian, 29 F.3d at 695 (holding that the defendant’s multiple, deliberate
misrepresentations constituted a pattern warranting an injunction). Accordingly, the court grants
the plaintiff’s request for a permanent injunction.
IV. CONCLUSION
For the foregoing reasons, the court grants the plaintiff’s motion for default judgment and
for a permanent injunction. An Order consistent with this Memorandum Opinion is separately
and contemporaneously issued this 31st day of August, 2010.
RICARDO M. URBINA
United States District Judge
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